Question

Shalini, after acquiring a degree in Hotel Management and Business administration took over her family food processing company of manufacturing pickles, jams and squashes. The business was established by her great grandmother and was doing reasonably well. However, the fixed operating costs of the business were high and the cash flow position was week. She wanted to undertake modernization of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately Rs. 50 lakhs would be required for undertaking the modernization and expansion programme. He also informed her that her stock market was going through a bullish phase.

1. Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernization and expansion of her food processing business. Give one reason in support of your answer.

2. Explain any two other factors, apart from those stated in the above situation, which Shalini should keep in mind while taking this decision

Answer 1

1. Debt

reason:

i) Due to weak cash flow position, the firm may not be able to honour fixed cash payment obligations.

ii) Increased fixed operating cost will increase the business risk therefore debt should not be issued as it further increases the financial risk.

2. The stock market condition being bullish, the investors will prefer to buy equity shares.

Other factors which Shalini would keep in mind are:

•  Return on Investment : Shalini needs to assess the potential profitability of her investment in modernization and expansion. It helps her determine if the investment is financially worthwhile. 
• Tax rate : Shalini should consider the impact of taxes on her investment decisions. Understanding tax implications helps her optimize her tax liabilities and cash flow.